Whose Money is It Anyway? Personal Finance Approaches Tax-savings first Product-first Returns-first...

Whose Money is It Anyway?

Personal Finance Approaches• Tax-savings first

• Product-first

• Returns-first

• Needs first • Products-last• Tax-planning incidental

Goal-based investing

What is goal-based investing?

Permanent loss in capital

Permanent loss in capital

We cannot expect more because we cannot invest enough!

With 8% inflation• 12% return 5000 monthly investment• 6% return ~10,000 monthly investment• Takes 19 years to achieve goal

• What if I invest 10,000 pm in an instrument that offers a real chance to beat inflation?

• Can achieve goal 9 years earlier.

Inflation in India: Some Real Numbers

Jan 1995 to May 2014

kyunki saas kabhi bahu thi yojana

Your RetirementOther long-term goals

Accident insurance

Term Lifeinsurance

Emergencyinsurance

Health insurance

Inflation insurance

Returns do not matter!yearscorpus inv(1 return)

yearsinvcorpus (1 )return

returncorpus (1 )inv years

• Rs 1 grows at 8% for 20 Y ~ Rs. 4.7

• Rs. 1 grows at 12% for 20Y ~ Rs. 9.6

• Difference ~ 107%

• Rs 1 grows at 8% for 5 Y ~ Rs. 1.5

• Rs. 1 grows at 12% for 5Y ~ Rs. 1.8

• Difference ~ 20%

yearscorpus inv(1 return)

Power of non-compounding

Power of compounding does not matter for ~ 5Y or less

Saving vs. Investing

~ 5 years

Saving Investing

Choose not to Worry Inflation

Returns Choose not to worry

Importance of beating Inflation, grows with duration

Importance growsWith duration

Taxation Choose not to worry

Importance growsWith duration

Why not have some equity exposure?

Is not 5/7 years long-term?!

Year 1 Year 2 Year 3 Year 4 Year 5

10% 9% 8% 7% 6%

5

Investment = 100

After 5 years:

?

100× 1+10% 1+ 9% × 1+ 8% 1+7% 1+6%

100× 1+

5

After 5 years:

100× 1+10% 1+10% × 1+10% 1+10% 1+10%

100× 1+10%

Year 1 Year 2 Year 3 Year 4 Year 5

10% 10% 10% 10% 10%

5

Investment = 100

After 5 years:

100× 1+10% 1+ 9% × 1+ 8% 1+7% 1+6%

100× 1+CAGR

Year 1 Year 2 Year 3 Year 4 year 5 CAGR10% 10% 10% 10% 10% 10.00%

Year 1 Year 2 Year 3 Year 4 year 5 CAGR25% 7% 7% 7% 7% 10.05%

Year 1 Year 2 Year 3 Year 4 year 5 CAGR-25% 21% 9.96%

Year 1 Year 2 Year 3 Year 4 year 5 CAGR-25% 7% 7% 7% 7% -0.34%

Illustration: Volatile Compounding

Year 1 Year 2 Year 3 Year 4 year 5 CAGR25% -25% 7% 7% 7% 2.81%

Liquid Mutual Funds

• Savings bank account linked to bond market

• Invests in short-term bonds (4- 91 days)

• Sensitivity to interest rate change: low

• Risk of default: low

• Least volatile among volatile asset classes

HDFC Liquid Fund

Average

Arithmetic average ~ 7%Standard deviation ~ 2%CAGR ~ 7% (12 year)Difference ~ 0.02%

HDFC Liquid Fund

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

7.1 4.96 4.36 5.3 6.5 8.12 8.9 5.29 5.15 8.8 9.56 9.28

5.644

5.848

6.636

6.822

6.792

7.252

7.54

7.616

Discrete Rolling Return

Understand risks before investing

Continuous Rolling Return- 2Y

2048 Two year intervals betApril 3rd 2006 to Dec 4th 2014

April 3rd 2006 to April 2nd 2008April 4th 2006 to April 3rd 2008April 5th 2006 to April 4th 2008

Continuous Rolling Return- 2Y

Debt oriented balanced funds(<20% equity)

AMC suggested investment horizon 1-3 years

vs.

Equity oriented balanced funds(> 65% equity)

AMC suggested investment horizon 3-5 years

1 year rolling return

3 year rolling returns

5 year rolling returns

7 year rolling returns

Understanding the nature of stock market returns

Sensex Total Returns Index: 1979 to 2013

Sensex Total Returns Index: 1979 to 2013

Sensex Total Returns Index: 1979 to 2013

5%

S&P 500 Total Returns Index: 1871 to 2013

Source: http://www.moneychimp.com/features/market_cagr.htm

12%

Sensex Total Returns Index: 1979 to 2013

Normal Distribution

Source: http://www.mathsisfun.com/data/standard-normal-distribution.html

Mutual Fund Star Ratings

Source: MorningStar.com

Sensex 1979 to 201315 year CAGR

Transformed Distribution: Square Root

14% +/- 4%

Higher risk does not imply higher return!

Return

RiskStandard Deviation

Higher risk does not imply higher return!

Return

RiskStandard Deviation

FD

Debt mf Equity mf

Gold

How Important is

Mutual Fund Selection?

Large Cap funds• 10-year old funds: 34

• 13 index + LIC Nomura+ JM fund

• 10 year SIP XIRR

• Baroda Pioneer Growth: 14.45%

• UTI Equity: 17.68%

Mid and Small-cap funds• 10-year old funds: 20

• 17 + Sahara+Escorts+Taurus

• 10 year SIP XIRR

• ICICI Value Discover: 24.23%

• Kotak Mid-cap: 18.03%

Essentials of a good portfolio

• Minimalist : We must be able to justify the presence of each asset class or instrument.

• Minimum number of asset classes

• Minimum number of stocks, equity funds or debt products

• This will typically make the folio diversified among and within asset classes

Simple portfolio ideas

Equity (60%) 10% return

1. Single Large Cap fund

2. One large cap +one mid/small cap fund

3. Single Large and mid-cap fund

4. Single equity oriented balanced fund

Debt (40%) 8% return (pre-tax)PPF for 15+ Y goals for options 1,2 & 3 (do not max!)

Ultra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds

Long-term goals (10+ years)

Simple portfolio ideas

Equity (0-40%) 8% return

1. Single Large Cap fund

2. One large cap +one mid/small cap fund

3. Single Large and mid-cap fund

4. Single equity oriented balanced fund

5. Single debt oriented balanced fund

Debt (100-60%) 8% return (pre-tax)Ultra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds

Medium-term goals (5-10 years)

Simple portfolio ideas

Equity (0-10%) expect nothing!

1. Single Large Cap fund

2. One large cap +one mid/small cap fund

3. Single Large and mid-cap fund

4. Single oriented debt balanced fund (5Y)

Debt (100-90%) 6-7% return (pre-tax)FDs, RDsUltra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds

Short-term goals (0-5 years)

Return expectation

• Equity allocation60%

• Debt allocation 40%

• Equity expectation 12% (after tax)

• Debt expectation 6-7% (after tax)

• Portfolio expectation

10%(60%) + 7%(40%) = 10% (approx.)

Investments are assumed to start simultaneously

Years to goalPresent costInflation Post-tax rate of return of portfolio 10%

Future CostAmt invested so farPost-tax rate of return on current investment

Future value of curr. Inv. Annual increase in monthly invest. %Initial monthly investment required

Annual increase in monthly invest. %Initial monthly investment required

Goal Planner

How many funds should I hold?

• Minimum:

2-3 funds! (all goals combined into one)

• Maximum:

No of long-term goals (10Y+) x (1 or 2)

How to select an equity mutual fund?

• Decide on the strategy.

(1)Why are you investing?

(2) What kind of portfolio will you be using?

Equity mutual funds: How to select/evaluate

Equity mutual funds: How to select/evaluate

Equity mutual funds: How to select/evaluate

Upside Capture ratio: When the benchmark has given a positive return (> 0), has the fund outperformed it?Higher (> 100%)  the upside capture ratio, the better. 

UPC = 120% => 20% out-performance during up-market

Downside Capture Ratio: When the benchmark recorded a loss, that is a negative return (< 0), did the fund record a lower or higher loss?Lower the downside ratio (<100%), the better. 

DCP = 85% => 15% out-performance during down-market

Equity mutual funds: How to select/evaluate

Source: http://thefundoo.com/welcome/articlepage/44/Are+you+invested+in+the+Ideal+Outperforming+schemes%3F

Rolling returns analysis

3YFund (blue)

Vs benchmark

5Y

How to select a debt mutual fund?

Understand risks• interest rate risk capital gain/loss• credit risk accrual

How to select a debt mutual fund?

Interest rate risk

Creditrisk

How to select a debt mutual fund?

How to select a debt mutual fund?

How to select a debt mutual fund?

Portfolio with 50% equity and 50% debt

Asset Allocation

Maximum Loss: worst case scenario

Asset Allocation

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD 40% Eq >60% Eq 100% Eq

10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq

>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD/Debt ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD/Debt 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD/Debt 40% Eq >60% Eq 100% Eq

10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq

>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq

Retirement Planning

Corpus ~ 300 times current annual expensesCorpus ~ 38 times annual expenses at retirement

Invest as much as you spend each month for retirement!

Financial Goal Tracking

• Be obsessed over goal planning entries not over mutual fund corpus